美商藝電 (EA) 2006 Q2 法說會逐字稿

Good day, everyone, welcome to the Electronic Arts second-quarter fiscal year 2006 earnings conference call.

Today's call is being recorded.

For opening remarks and introductions I would like to turn the call over to Miss Tricia Gugler, Director of Investor Relations.

Please go ahead.

Good afternoon and welcome to our second-quarter fiscal 2006 earnings call.

Today on call we have Larry Probst, chairman and chief executive officer, Warren Jenson, chief financial and administrative officer and Frank Gibeau, executive vice president and general manager of North American publishing.

Before we begin I would like to remind that you you may find copies of our SEC filings, our earnings release, and a replay of our webcast on our web site at investor.EA.com.

Shortly after the call we will post a copy of Warren's remarks on our web site.

Throughout the call we will present both GAAP and non-GAAP financial results.

Non-GAAP results exclude charges associated with restructuring, asset impairment, other temporary impairment of investment and affiliates, [inaudible] in process technology, amortization of intangibles, employee stock-based compensation, and certain nonrecurring litigation expenses and their related tax effects.

In addition the Company's non-GAAP results exclude the impact of tax adjustments.

A supplemental schedule to our earnings release provides the reconciliation of non-GAAP to GAAP measures.

In addition a supplemental schedule demonstrating how we calculate ROIC will be included on our web site.

All non-GAAP measures are provided as a complement to our GAAP results and we encourage investors to consider all measures before making a decision.

All comparisons made in the course of this call are against the same period of the prior year unless otherwise state.

We have included our trailing 12-month platform shares in our 2005 estimated market outlook in a supplemental schedule that will be posted on our web site.

During the course of this call we may make forward-looking statements regarding future events and the future financial performance of the company.

We caution you that actual events and results may differ materially.

We refer you to our most recent form 10-K and 10-Q for a discussion of risk factors that could cause our actual results to differ materially from those discussed today.

We make these statements as of November 1, 2005 and disclaim any duty to update them.

Now I would like to turn the call over to Warren.

Thanks, Trisha.

Good afternoon, everyone, and thanks for joining us.

Our second-quarter results were solid, netting the ins and outs of title moves, particularly FIFA in Europe, we extended the top end of our revenue guidance and soundly came ahead on the bottom line.

Sports is off to a great start.

Our North American segment share is a record 75%, up 7 points from this time last year.

Of the top ten sports titles, we have nine on the PS2 and eight on the Xbox.

Madden NFL '06 took only three weeks to become the number one console title for the year in North America.

Through the end of the quarter, we sold an excess of 4 million copies.

With 12 weeks of retail data, we estimate sell-through is up in the high teens year-over-year.

NCAA Football 2006 has sold over a million and a half copies, and we estimate sell-through is up over 15%.

FIFA 06 launched very strongly.

So far we estimate our sell-through is pacing more than 30% ahead of last year, FIFA was at the top the charts in Europe for three consecutive weeks.

The competition is heating up, but we are very pleased with our performance and like our prospects.

NBA Live 2006, while only a week's worth of industry numbers are formally in, we estimate that we are outselling our nearest competitor by a factor of 5.

NBA Live has now surpassed the billion dollar lifetime sales mark becoming EA's fifth billion dollar franchise.

Burnout Revenge sold more than 1.8 million copies and joins Battlefield 2 as the top ten rated title for the year.

Year to date our overall quality rating as measured by Metacritic leads all major third-party publishers, Roughly 50% of our titles have been rated 80 or higher, double the industry average of 24%.

On the PSP, we were the number one publisher in North America with a 27% segment share and four top ten titles.

In Europe, we estimate that our segment share was approximately 16% and that we were the number one third-party publisher.

Now while we are pleased with our overall title performance in the quarter to be balanced, we have also seen some recent softness at retail in North America.

On mobile phones, we continue to build our foundation.

We have recently entered into a distribution agreement with Vodaphone to deliver games in Europe, Egypt, Austrailia, South Africa and New Zealand.

In addition, during the quarter, our games did well.

For September, we have four top 20 titles on Verizon mobile handsets, Madden 2D, Poppit, Madden 3D and Need for Speed Underground 2.

In the UK, FIFA is already the number one title on the Vodaphone platform.

We are also pleased this quarter to have announced a groundbreaking partnership with Steven Spielberg for the creation of three new intellectual properties.

In summary we think we are off to a solid start for the year.

For next few minutes, I will focus my remarks in two areas.

First, I will review our Q2 financial results and second I will go over our outlook and financial guidance.

Following my comments, Larry, Frank, and I will open the call to your questions.

Q2 performance.

Net revenue was $675 million down 6% from a year ago driven by lower PC, console and co-publishing related revenues.

Partially offset by a significant increase in revenues for mobile platforms.

Remember that last year we launched Sims 2 on the PC.

This quarter we released 37 SKUs in the quarter, of which seven were associated with mobile platforms.

Last year we launched 33 SKUs, two of which were mobility based.

Six titles went platinum in the quarter versus four a year ago.

Madden NFL '06 , NCAA Football, Burnout Revenge, FIFA 06, NBA Live and The Sims 2 Nightlife.

As compared to our Q2 guidance, product shifts added approximately $30 million net to our top line and approximately $.05 as GAAP and non-GAAP EPS.

Console revenue was $467 million down 5% year-over-year.

While there were single-digit declines on both the PS2 and Xbox, the most significant decline was on the Game Cube.

PC revenue was $91 million, down 35% due to the strong launch of The Sims 2 last year.

This decline was partially offset by the continued strength of Battlefield 2.

Mobility, revenues were up fivefold to $62 million.

The increase was driven by the PSP and to a lesser extent the NDF.

The European PSP launch was solid.

In Europe Burnout Legend, the Need for Speed Rivals charted in the top five games.

Co-publishing and distribution revenue was $32 million, down $17 million year-over-year driven by the reclassification of the Battlefield franchise to PC.

Internet services, licensing and other was $23 million, flat to last year.

As of today, Club POGO paying subscribers have reached 1 million, up 75% from a year ago.

Geographically, North America revenue was $443 million down $30 million or 6% year-over-year.

All console platforms in the PC were down in the quarter while overall mobile revenues were up significantly.

Essentially the improvements in mobile did not completely offset the prior year strength of Def Jam Fight for NY and The Sims 2.

Europe revenue was $191 million down $19 million or 9%.

The decrease was driven principally by lower PC and co-publishing related revenue which was partially offset by sales on the PSP and PS2.

Console revenues for the quarter were flat year-over-year given this year's launch of FIFA.

Asia revenue was up 24% year-over-year, driven primarily by the PSP and PS2.

Changes in foreign currency rates had no significant impact on our top line in the quarter.

With that said, we continue to expect currency movements to negatively impact the back half of the year.

Moving on to the rest of the income statement.

Gross profit in the quarter was $391 million, down 9%.

Gross margin was $ 57.9% versus $60.3 a year ago.

The decline was driven by higher licensing royalty rates and a higher mix of royalty-based titles.

These negatives were partially offset by lower development royalties.

Last year we accrued for royalities on Burnout.

This year we own the IP.

Marketing and sales.

Marketing and sales expense was $107 million flat to last year.

G&A.

G&A was $52 million, up $10 million year-over-year and relatively flat with last quarter.

The year-over-year increase was primarily driven by increased headcount, a slight increase in litigation cost, and slightly higher bad debt expense.

While this increase is significant, we continue to expect G&A for the full year to be up in the mid single-digit range.

R&D.

R&D was $182 million, flat to last quarter, and up $25 million from a year ago.

The increase was driven primarily by higher staffing levels, resulting from the development of next generation tools, technologies, and titles.

This increase was partially offset by lower third-party development advances in the quarter.

R&D related headcount was up 39% to roughly 4700.

Acquisitions account for approximately 12 points of this increase.

Please remember that we are investing ahead of next generation revenue.

We record the expense today, but the revenue comes later.

Diluted earnings per share was $0.16 versus $0.31 a year ago.

Non-GAAP diluted EPS was $0.15 versus$0.31.

Our effective tax rate was 15% versus 29%.

Our Q2 rate includes a $9 million favorable net tax adjustment.

This amount was excluded from our non-GAAP result.

Our trailing 12-month operating cash flow was $592 million versus $664 million for the comparable period.

We have now completed our $750 million share repurchase program, buying a total of 13.4 million shares.

Our diluted share count was $314 million versus $316 million a year ago.

On to the balance sheet.

Cash, short-term investments, and marketables were $2.4 billion down 686 from March.

The decrease relates primarily to the repurchase of our common stock.

Gross accounts receivable were $465 million versus $502 million a year ago, a decrease of 7%.

Reserves against outstanding receivables totalled $137 million, up 11% from a year ago.

Reserve levels were 13% as a percentage of trailing six-month net revenue, up two points from last year.

As a percentage of trailing nine-month net revenue reserves were 9%, also up 2 points.

Inventory was $74 million, up $8 million from June, driven by the inventory build for the launch of FIFA 06.

Other than FIFA no one title represented more than 4 million of net exposure.

Now on to our outlook.

Before we get into the numbers, let me just stop and mention a few things.

First, we are ready for the Xbox 360.

We will be supporting the launch with five great titles including madden nfl, need for speed, fifa road to the world cup, tiger and nba live.

By year end we plan to release three additional 360 SKUs, Fight Night Round 3, Battlefield Modern Combat, and Burnout Revenge.

Currently we are actively developing over 35 SKUs for the Xbox 360, PS3 and Revolution.

Second, we are ready for the holidays.

Need for Speed Most Wanted and Harry Potter look great and we expect will be solid hits.

These titles will be bolstered by FIFA, The Sims 2 on console, Battlefield Modern Combat,and James Bond From Russia with Love to name a few.

Our titles will be supported with marketing campaigns second to none in the industry.

When you consider the absolute dollar amount we invest in marketing versus that of our competitors, the breadth and depth of Our reach is unparalleled.

Third, we have a strong lineup of new titles.

In the second half of the year, we expect to launch several new first-time titles including Godfather, Black, Arena Football, NCAA Baseball and NFL Head Coach.

Owned intellectual properties.

For the year we expect revenues from owned IP will exceed $1.3 billion, an increase of 15% year-over-year.

And finally, a final word of caution.

Expect the unexpected.

We are in transition.

We could experience production or development snags or abrupt changes in pricing or demand.

In addition, as I mentioned earlier in the call, we have seen some recent weakness in North America.

I'll conclude my portion of today's call with our market outlook and financial guidance.

Our overall market outlook is essentially unchanged.

As Tricia mentioned you can find a detailed summary on our web site.

Now on to our financial guidance.

The following forward-looking statements reflect our expectations as of November 1, 2005.

Our actual results may be materially different and are affected by many factors such as consumer spending trends, the popular appeal of our products, development delays, current generation and next generation hardware availability, the seasonal and cyclical nature of our industry, the overall economy, competition, changes in foreign exchange rates, our effective tax rate, and other factors detailed in our earnings release and in our SEC filings.

Now to the numbers.

For the full year, we expect revenue to be between $3.25 and $3.4 billion.

GAAP diluted earnings per share to be between $1.40 and $1.55.

Non-GAAP diluted earnings per share to be between $1.45 and $1.60.

Please note that our GAAP results include up to a $.05 charge associated with the European reorganization and establishment of an international publishing headquarters in Geneva.

We expect the charges to be split roughly evenly between our third and fourth quarters.

For the quarter ending December 31, 2005, we expect revenue to be between $1.475 and $1.575 billion.

GAAP diluted earnings per share to be between $1.15 and $1.25.

Non-GAAP diluted earnings per share to be between $1.18 and $1.28.

Specifically in the third quarter, we expect to ship 54 SKUs.

Our expected lineup for the third quarter includes Battlefield Modern Combat on console, Modern Combat Mass Expansion Pack on Xbox, Battlefield 2: Special Forces Expansion Pack for the PC, Black and White 2 on the PC, Burnout Legends on NDF, FIFA '06 in North America on four platforms, Half-life 2 on the Xbox, Harry Potter and the Goblet of Fire on seven platforms, James Bond From Russia with Love on three, Lord of the Rings Tactics on the PSP, Marvel Nemesis on two platforms, NBA Live '06 on the PSP, NCAA March Madness '06 on the PSP, Need for Speed Most Wanted on seven platforms, Need for Speed Most Wanted Collector's Edition on three platforms, The Sims 2 on console and hand-held, The Sims 2 Holiday Expansion Pack, Sims bundle for the PC, Total Club Manager '06 on the PC, SSX on Tour on four platforms.

On the Xbox 360 we plan to launch five titles, Madden NFL '06 , NBA Live '06, Tiger '06, FIFA "06 Road to the World Cup, and Need for Speed Most Wanted.

In addition, on mobile phones we plan to launch seven games.

In North America and Europe, FIFA '06, NBA Live 06, Tiger Woods Golf, Need for Speed Most Wanted and Sims 2.

In addition, we plan to launch POGO Harvest Mania and POGO Word Whomp in North America.

I will now conclude with a few closing thoughts.

First, we are very fortunate to be in the middle of one of the most exciting global growth trends in entertainment today.

Second, while there is plenty of risk and we certainly can and will make mistakes, we believe there is no company in a better position to take advantage of this opportunity than Electronic Arts.

And third, rest assured, as the team and as a company, we are investing for sustained long-term leadership and we are intent on winning.

With that, Larry, Frank and I will open the call to your questions.

Operator?

Thank you, sir. [Operator Instructions] And we will pause for just a moment to assemble our roster.

First question comes from Gary Cooper from Banc of America.

Okay, thanks.

So a couple of questions, guys.

First, the competition, particularly in NBA basketball.

Looks like they are probably going to cut their price.

I am wondering if you anticipate you will cut your pricing on sports games, and specifically do you think that you will take Madden down to $39.99 by, say, Thanksgiving.

I got a couple more.

Thanks.

In terms of the Madden price break, we have not made that decision to move to $39.

We are looking at all titles in our mix right now and the timing of price moves versus what's going on in the marketplace.

We feel very good about our sports positioning overall.

All of our titles are performing extremely well.

Specifically if you look at NCAA and Madden they are up double digits year-over-year.

In basketball we feel very good about our competitive positioning and on the 360 we have four new sports launching [inaudible] that we believe will set a momentum in November and December that will be very positive for our sports brand for the rest of the line.

Okay.

Two more.

So it looks like the Q4 guidance is pretty robust here.

Godfather still in there.

Can you get us in the ballpark of how large you expect that game to be and secondly your advertising line.

Last year in the holiday quarter, the advertising spend was way down due to the price reductions and we heard from several people in the industry that EA is not being aggressive in terms of its advertising spend.

Can you get news the ballpark of what you think your second half advertising will be like?

I will take the question on Godfather.

We will not give you a specific number but we're feeling very good about the title and it is progressing well in the development process, and, again, we are very bullish about that title and its prospects during Q4 in the launch period.

I will take at least the first part -- the first part of the question, Gary and then I will ask Frank to provide a little bit of color.

I think the good news is, as we look into Q4, we like what we are seeing.

When you look at where the PSC is, how it is launching in Europe, and how well our titles are performing, we think that is a positive.

I think, you know, by way of -- it is more of a factoid as opposed to a trend per se, but for the month of September I believe our segment share on the PSP was over 40.

Last week looking at chart track in the UK, six of the top ten games were EA's games on the PSP.

So, one, we like what we are seeing in terms of the entertainment quality that we are providing.

We like the increased momentum of the PSP.

Two, is we like what we are seeing from our Xbox 360 titles.

So whether it's the addition of the next three titles in looking ahead to Q4, we like what we are seeing.

So we think there are -- there are several positives that bode well hopefully for the fourth quarter.

I don't know, Frank, if would you like to add any color to that.

The only color I'd like to add on the advertising and sales and marketing support front is that wWe are very confident in the span and positioning that we have for our holiday releases.

If you look at the Xbox 360 rollout plan, we will be supporting that with dedicated advertising and marketing that will trumpet the high quality of the titles, as well as the deep and innovative game-playing technology.

If you look at Harry Potter, James Bond and our Need for Speed Most Wanted launch, all of those are premium titles with very substantial media spends and support across the board.

Our next question comes from Brian Pitz from Morgan Stanley.

Hey, guys.

Congratulations on a good quarter.

Can you talk about what you have learned from the development of the Xbox 360 platform.

Are efforts and costs coming in better than your expectation?

And then just a quick comment on -- thoughts on possible price cut for existing consoles this holiday season.

It doesn't seem likely, but can you maybe handicap the chance for that?

Thanks.

I think it is unlikely that you will see price cuts on the current generation consoles.

And I would add to that, I think it is really good news that the channel seems like we will be fully supplied with Playstation 2s this year which was not the case last year.

I think that is a positive for the overall business.

With regard to development costs on Xbox 360, it is a little too early to draw any conclusions.

The first round of titles is probably costing us in the range of $10 million to $15 million, but, again, I don't think that is predicted for the long term.

It is too early to make any predictions about exactly what next Gen is going to cost.

Our next question comes from Glen Reid from Bear Stearns.

Hi, good afternoon.

A couple of quick questions.

You mentioned you are seeing some softness North America.

I was wondering if you could be a little more specific in whether that is any specific, you know, market or types of games, and then following up on the Xbox 360 and maybe the Playstation 3, I wondered if you could comment.

There's been a few game delays and I am wondering if perhaps -- we all know costs are going up, but if there's been any sort of learning curve that's been steeper than was thought and we might see more delays and then finally R&D spending, you know, if we could -- if you could comment on the rate of growth and whether or not this will be the peak year in terms of percent of revenue or maybe we have some more spending in next year.

Thanks.

I'll take a cut at the softness in retail.

I don't think it is any surprise that retail in general has been off to some degree in the month of October.

I think that is across the board in all categories.

It has a lot to do with the continuing aftermath of the national disasters that have occurred and $3-per-gallon gas.

I think in our particular category, there are also some people sitting on the sidelines saving their money for the launch of Xbox 360.

So having said all those things, I think there are some real positives ahead for the overall -- for the overall industry in our category, and as I mentioned earlier Playstation 2 hardware will be fully supplied.

We have the PSP platform we didn't have last year, and once the Xbox 360 launches, there is going to be a lot of excitement around that in the channel both in North America and Europe.

There are many positive things that we will see happening in the months of November and December and through the holiday season.

I would add just one thing to that plan, and I will jump into the second part of your question.

The other thing to make note of is -- is Europe is also performing very, very well.

Whether it is the month of September or the month of October for that matter.

They are pacing strongly and in a great position across the board, so whatever that weakness is that we are seeing in North America, that has not been evident in Europe.

Secondly, on -- on the delay side.

First I would say that, look, we are always cautious, but yet we are -- we believe in what we said relative to our SKU plan for the year, and -- and we are cautiously optimistic and feel that our titles will ship as planned.

Could there be future delays or delay?

You bet.

This is entertainment.

It's software.

And also as it relates to these next generation titles, we are really inventing how to build a title today for the Playstation 3.

On the cost side for next year looking at our fiscal year, I -- I won't -- I don't think we are in a position that we can be pinned down today.

We really haven't -- we are just really ramping into the full-scale development of the Playstation 3.

If you had to -- if I had to put a number around it, I would sort of say that 10% to 15% year-over-year growth, but again that's just sitting here today well ahead of our planning process and well ahead of really understanding what it will take to build a Playstation 3 game.

Thank you.

We move on to Justin Post with Merrill Lynch.

Great.

Can you get a little more clarity on the fourth quarter.

It looks like a pretty big revenue growth quarter on a year-over-year basis.

Can you talk a little bit about what the key titles are for that beside Godfather.

Anything else in that quarter?

The other title we are very excited about is Black, which is being developed by our Criterion Studios.

That is finishing extremely well.

We have high expectations for that.

That is wholly-owned intellectual vorts that makes it doubly important for us.

FIFA Street will be launched on five platforms in Q4.

Fight Night III will be launched on four platforms.

That product looks extremely strong as well.

Expansion Pack on The Sims 2.

NCAA Baseball in that quarter.

So it is a very strong line-up with some exciting new products that are debuting from Electronic Arts.

I think Frank mentioned that earlier, Godfather, Black, arena football, coach, and NCAA Baseball is all brand new and the two that we are focused on are Godfather and Black.

We think those are going to be home runs.

Great.

Okay Larry and one more, on Playstation 2, when that launched you guys came out with I think 40% market share, really had industry leadership which would carry through for a couple of years.

Can you discuss any similarities and differences you are willing to talk about the Xbox 360 launch as it kicks off the cycle?

We intend to be prolific in terms of the number of titles that -- that we will publish for that platform.

I think we mentioned we will have five during the launch window.

We will have eight in the marketplace by the end of our fiscal year.

And I would say that next fiscal year, although we haven't finalized our planning process, you can expect something in the range of 20 to 25 titles on the Xbox 360 platform next year.

We expect to be aggressive, we expect to be prolific.

We think our products are very high quality relative to -- to everybody else that is launching in the introductory window, and I am not going to predict that we will have market share that begins with a 4, but we expect to have a significant market share.

Thank you, we go next to Anthony Gikas with Piper Jaffray.

Hi, guys.

A couple of questions.

Has there been a profitability drive for some of the Playstation Portable products that you put in the market.

It looks like you captured the market share that you were looking for and I guess I was wondering how development expenses are playing out.

Are they coming in below plan?

Second question.

You talked about the Xbox 360 titles.

Do you anticipate that all of those will launch at the $59.99 retail price point and then I have a quick follow-up?

Tony, I'll take the first part.

I would say, you know, overall pretty much as planned on the PSP.

Growth margin wise, we are pretty much in line -- slightly ahead of the average for the quarter.

On development side, as you know, one of the things that our studio team did very early on was we built an organization that we call Fusion.

And the reason that we did that was we wanted to figure out ways to build economies of scale around the development of high quality titles for the PSP and I think that early investment while painful from an income statement to make early on continues to pay dividends in terms of overall long-term profitability.

Development costs, I would put titles on average sort of in the $2 million to $3 million a copy.

And that's where we stand today and look to get -- continue to drive more synergy and higher quality as we go forward.

What I would add to that with regard to market share.

First, for year-to-date in North America we are running about a 26% market share.

That actually exceeds our internal expectations when we originally planned the business on the PSP.

I think Warren mentioned we had six out of the top ten titles, most recently in the UK.

We also have the top four.

So our PSP titles are performing very, very well in Europe and North America.

We are very happy about that.

The second question on the 360 price point, we will be launching our lineup at $59.

When you look at the titles and the incredible breakthrough quality that they have, the $59 price point does match against what we are providing as entertainment.

On a broader -- broader response, our form of entertainment is still the most competitive that there is out there on a price-per-hour basis even at the $59 price point.

Thank you, we go next to Edward Williams from Harris Nesbitt.

Good afternoon.

A couple of questions.

First of all, Frank, can you give us a little more color of the retail environment going into the holidays, specifically if there are platforms that are at risk, such adds how is the Xbox performing with the 360 launch is about to come and a couple of other questions.

[FRANK?]In terms of platform mix right now, year-to-date the Xbox platform is performing very well.

You do see a bit of cross ownership between the Playstation 2 owners and Xbox owners.

What they are doing is buying the Xbox version of games.

Now how the 360 introduction changes that, we don't know yet, but to date that's where we have seen some strength.

In terms of the handheld, the PSP is doing quite well with the recent releases of Liberty City and Madden and we anticipate a strong Christmas with the handheld mix but the NDF is doing very well with the product and hanging around very competitively at several accounts.

We move next to Evan Wilson from Pacific Crest Securities.

Hi there.

Thanks for taking the call.

I was hoping you could give us a little more detail on the catalyst for moving FIFA in Europe into the quarter.

I know that we always like to think on this side of the Street because the quarter is light, but I know that is not the case.

Also I wanted to know what the primary driver was for lowering the bottom of the revenue guidance.

Would you say that was specifically the weakness in the North America retail environment?

I will take the first part of that question.

It is really simple.

The product was finished.

It was -- we thought it was extremely high quality, and we wanted to get to the market place first ahead of Pro Revolution Soccer and that strategy has worked extremely well for us.

We are exceeding expectations an the title is performing extremely well but it was simply get to the market first.

And as to the guidance question on the top line, if you were to point to a single factor, it was recognize -- recognizing the weakness we have seen in North American retail during, say the month of October.

And or just exercising caution around that weakness.

Our next question comes from Shawn Milne from Friedman Billings.

Thank you.

Warren, I want to see if I can go back to that.

You just indicated in the last comment "the month of October."

Can you be a little more specific.

I have been hearing that PS2 hardware sales were stronger at the end of October versus the beginning of October.

Any granularity around that would be helpful and I assume the guidance you have now given on the top line for December incorporates the October sell-through.

That kind of weakness as you put it staying the same for the quarter?

I would say in -- and I will ask Frank to provide -- to jump in, too, here, shawn and give more, specifics around this.

But what I would say is, you know, for us, we saw some ups and some downs.

While we clearly feel that there was weakness in buying, and we saw it, I think, overall at retail, and we are also sitting here with sell-through rates on Madden that are pushing 20% and NCAA, that it was over 15%.

Furthermore, you take a look at Europe having had the strongest launch in our history on FIFA, and we continue to see a very robust environment, so my point would be there are still ups and downs within that overall weakness of some buys being consolidated, and I think some launches across the board, we are talking more the breadth of the industry not being as expected.

With respect to our guidance, what we try to do, as we always do, is we go through and look on a title-by-title basis, a SKU-by-SKU basis, and country-byY-country basis and look to analyze what we expect the sales to be based on the marketplace and we believe what we will expect.

This quarter was no different.

What we felt was relevant, though, was the softness that we have been seeing, and we felt that that warranted lowering our revenue guidance for the year just on -- on the bottom end.

And specifically on Playstation 2, with regard to hardware sales.

They've sold about 3.3 million year to date in North America.

I think I have seen that Sony has projected something like 6 to 6.5 million units for the calendar year.

We agree with that sort of outlook.

That means alot of hardware will get sold in the last three months of the year and alot of software will get sold behind that.

I think that is a potential plus for the business.

Our next question comes from Jeetil Patel from Deutsche Bank.

Great.

Two questions, guys.

You know, if you look at the North American weakness, if it continues, can you talk about your strategy as it relates to kind of combatting that or kind of offsetting it.

Would it be primarily through pricing?

Or do you think advertising kind of represents your biggest point of leverage as you go forward, especially this holiday season when, you know, I think a lot of retail demand will be out there for 360 and kind of spillover to the rest of the category on the existing console side.

Second, your guidance implies about 30 to 35% growth for the fiscal fourth quarter.

Is there a, you know, heavy orientation of SKUs in that particular quarter?

Is Is that a pretty good kind of growth rate to kind of think through as you look at, you know, kind of the rampup of the next cycle or is it more specific to Godfather kind of landing in that quarter from previously being in the December quarter.

I will take a cut at the first part.

We will look at all things in the mix, including pricing and the marketing support that we are plan for our titles, but let's not forget that a very significant part of our business is generated by our European organization and our company in Asia.

Close to half of our -- of our total business.

And those -- those markets are both performing extremely well.

Specifically in -- in North America.

Again, we will take a look at pricing and we will take a look at marketing support, but as I mentioned earlier, I think there are alot of positive catalysts, not the least of which is plenty of Playstation 2 hardware, the PSP as a new platform and all the excitement generated around the launch of Xbox 360.

And then I would say and my partners can jump in looking at the fourth quarter, Larry went through alot of our SKUs and titles that we have planned and Jeetil, as we went through our planning, just as we did for this quarter, we look at our forecast for both hardware or our titles based on the quality we are seeing, and based on what we see, that's -- that is the right call.

Thank you.

We go next to Heath Terry from Credit Suisse First Boston.

Thanks.

I was wondering if you can talk more about your online business.

You mention a million subs on POGO at this point.

Can you talk about -- an overall sub number you can talk about to help the persistent state world business.

Also you talked about on the handheld side or the mobility side, you talked about Playstation 2 Oregon Playstation Portable and DS.

Are there any revenues at this point to talk about from -- from the cell phone side of things and just where are you right now or where would you have us thinking right now in terms of when that part of the business starts to become meaningful?

I think in -- Heath, I will try to take a stab at the first question, because I think it is -- it is a fairly broad one in its totality.

When -- when we think of the Internet, and the online business, I think you have to segment it into alot of different businesses.

There will be an Internet-based business on the console as there is today on Xbox Live.

There is a community-based online business like you might have at a IGE or even a POGO, you have casual games, you have MMO games, mid session games, like you might find with the Nexon (ph) in Korea.

What we have been working to do is lay a lot of foundation for the building of our online business over the coming years.

You know, ultimately what we do know is that content will rule, and so what we are doing now is trying to get our foundations laid in place so that we can take advantage of our content in an increasingly connected world.

So what do I mean by that?

Well, we have POGO in place which is building out of subscription bases.

We are building out our online infrastructure to be able to deal with what we would perceive more online connected players through EA Nation and through EA Sports Nation as an example.

We are working to build our online base capability today although still very much in its infancy globally in Asia.

So when it comes to online, what I would say our strategy is right now is to build out these foundations that will enable us over the coming years to take advantage of our content -- to take advantage of -- of our content.

I think it is important to note that -- because it is so overshadowed by really the packaged goods business and strength of our console business that we have an Internet presence today that when you look at our online revenues, it is pushing $100 million bucks.

So it is not -- it is not by any means -- we are a significant player today in online.

So Frank, if you want to add anything to that?

I think over time, you know, the multiplayer category is something of interest.

If you look at wait the PC business is working in North America, the worlds of warcraft and -- is shifting dollars of retail into online.

We recognize that and see that as an opportunity and believe we are well-positioned to start to build into that category.

And finally on your question on mobile-based -- mobile-based revenue.

I would say that what you are going to see is this build, Heath, over time.

Today it is very, very small, but we are expecting for the year to be somewhere in the neighborhood of 20 or so million.

In our income statement, we talk about 2 million bucks coming through cellular handsets in our second quarter.

There's also likely going to be a few million still coming through the licensing line as we roll into more of our own production.

But over time, we would expect that will -- that will build as we believe this will be a significant source of revenue both for the carriers, as well as for the game industry.

And in terms of product or publishing on the cell phone platform, we released about five titles in Q2, and in Q3 and Q4 combined, there are probably another 15 titles that we will launch.

Our next question comes from Arvind Bhatia of Southwest Securities.

Good afternoon.

A couple of broader questions looking out a few years.

I was wondering if you can comment on the growth that you expect in the next cycle.

Just broadly speaking, do you think you could look back the last cycle and view similar trends, you know, we could see more penetration and more International presence and things of that nature.

And then second question is on the margin.

Again longer term, as you look at EA, you know, specifically.

I think it took you only three years to get to the -- the high 20% type operating margin last cycle.

Should we expect a similar trajectory?.

Is there any reason trends on the operating margin side will be any different as you look out a few years?

With regard to our market outlook for calendar '06, we are not prepared to talk specifically about that yet.

We will probably get into that on the next call.

But at a macro level, I think next year will be pretty interesting year.

You will have the PSP install base continuing to grow.

I think you will see Microsoft very aggressively try to grow the installed base on Xbox 360, and we are expecting Sony to launch the Playstation 3 and Nintendo to launch the Revolution.

So a lot of new hardware will be delivered to the marketplace in calendar '06 in Japan, and North America and Europe and we think that is going to be pretty compelling and beneficial to all of the third-party publishers.

And I would add, you know just one thing to what Larry said and I will attempt to address the margin question.

I think what is increasingly becoming clear and will over the next -- increasingly becoming clear and will over the next 12 to 24 months, our initial measures for measuring this marketplace will become obsolete.

Heath already touched on this.

A huge business today in online that is not really being captured in what we would all call traditional market measures.

Increasingly, there will be microtransactions that need to be factored in trading-based revenues.

Increasingly, you also will see mobile become a factor.

One of the things when we talk to market growth very quickly we have to adapt to is sort redefining who we are as taking into account all of the opportunities that are fundamentally being created by technology.

Looking at margins, sitting here today, again, I am not willing to predict out.

I think what I would tell you is that margin upside is -- on the gross margin side is going to come from a -- factors of where do you see pricing, how quickly can these high margin revenue -- high margin income streams, revenue streams develop like microtransactions, in-game advertising and the like, and then ultimately, how we can take advantage of our scale in order to build scalability down through our operating costs.

And you know, one other thing which I guess I should absolutely add in here which is number one focus is new and wholly-owned intellectual property, because ultimately at the end of the day, the Q2 higher gross margins are owning the IP and not renting it.

Thank you.

We go next to Mike HIckey from Janco partners.

Hey guys, thanks for taking my call. just a couple of questions.

Could you update us on the -- out of RenderWare?

And are you realizingthe initial cost savings that you expected?.

I think -- I want to say something out of the box on cost savings.

I don't think that is the way to look at render ware.

Renderware for us is capacity.

When we think about it if if you look at our industry or EA, the industry has never been idea constrained.

It has never been capital constrained.

It has been capacity constrained as we are learning to build newer and better games given the changes in technology.

What we try to do, what we are working to do with Render Ware is to build this platform and put it in place that fundamentally allows us to do more and increase our throughput as opposed to per se save costs.

Ultimately should margins benefit as a result of that, yes.

As you drive higher levels of throughput.

That is the philosophy behind Render Ware.

I don't think you're going to really see the payback on this until we get right in the middle of next Gen development because that's when it kicks in as a platform as all of our titles start to move to this common platform.

The final thing that I want to be clear about with respect to Render Ware is that at its heart on top of being about capacity, it is also about innovation.

And the reason why it is about innovation is it allows us to consolidate the things that are repetitive.

The things that can be standardized and free up more time for our engineers to work on the creative and on the core game skills such as game play.

Again, we will have to build our way into it.

There is alot of learning that goes -- as part of it.

And we are right in the middle of that as we focus forward into Next Gen.

Thank you.

We go next to Colin Sebastian from Thomas Weisel partners.

Thanks.

I have a couple of quick questions.

First, with respect to the holidays, I am wondering what your expectations are, more specifically for Need for Speed and Harry Potter, at least in comparison to last year's titles or for Harry Potter, perhaps versus the last holiday title that accompanied a movie release.

And regarding your comment again on the reason we missed North America.

And we have heard alot about less up-front buying from retailers, and I am curious if that's consistent with what your -- with your comment, or if you were talking about something else more specifically for up sell-through.

And then lastly, Catalog sales, what percent was catalog in the quarter and what percent are you modeling for the March quarter for catalog.

Thank you.

Catalog versus new releases, in Q2 was approximately a 70-30 split.

And I would say that it's probably more heavily weighted toward new releases in Q3 and Q4.

On the other two aspects of your question.

On the first, we are very bullish on Need for Speed.

It doesn't have a direct competitor on the majority of the platforms it is shipping on.

It takes a very new approach to the game design that we had from last year, which was Underground 2 and are brings into a new area that's proving to be very exciting to customers.

We feel very strong about it.

We have a great campaign behind it.

Harry Potter, we are looking at a movie release at holiday which is great for product.

It is also our highest quality Harry Potter game to date.

It really follows the movie and is very innovative on its design and execution.

Additionally the sales and marketing effort on that is going to be extremely high.

With regards to retail open to buy.

We are seeing some caution amongst retailers given the conditions in the channel.

The good news for EA is that our brands in our products are proven historically to be performers at holiday and to be successful with customers.

So in a sense a lot of the titles that we are providing to retails are Safe Harbor for customers and for retailers so when they are making their showses on their open to buys, I think we will do very well this that context.

The other thing that I want everybody else -- I think we should also remember is that when both of these titles are extremely global.

Two, is, remember that if you go back a year ago, we weren't talking about launching on the PSP.

We weren't talking about an Xbox 2 launch.

And we weren't talking about the NDF.

So you've got some pretty powerful new platforms over which we can market these products.

Thank you.

We go to Mike Wallace from UBS.

Hi.

A couple of questions.

First, Warren, can you first tell us the tax rate assumption for the rest the year and what the share count is that we should be using.

Second question.

Larry, if you can kind of give us a road map through the next year, if you'll look at your expectations for Xbox hardware, you know, generally it seems $1.5 to $2 million worldwide in December.

Do you think there is more supply than that in the March quarter.

Timing of a PS2 cut.

Do you think you get a hardware cut on the PSP next year.

The latest thinking is Revolution is some time in the summer before the PS3, and maybe take us through what next year is going to look like to get a better idea of how the year shakes out.

With regard to the Xbox 360, I -- I think the range that you just mentioned for calendar year '05 is probably close to reality.

I think what is more important is what's going to happen in calendar '06, and my expectation is that Microsoft will work very hard and very aggressively to get to a 10 million unit install base on a global basis as fast as they can, and in their mind, probably hopefully before Playstation 3 launches.

And, you know, we can't make announcements for Nintendo or Sony, but our expectation is in North America and Europe, those are probably both second-half launches.

And I don't -- I frankly don't anticipate a price reduction on PSP next year.

Mike, on share count and tax rate.

Tax rate, you should expect for the year 28%, and, you know, and just understand that I think increase league you will see volatility in that line.

So give or take 28%.

But that's where I would model it and then on share count, I would put it right around 315.

Operator, we will take one more question.

Thank you.

We will go next to Chris [inaudlble]

Sure thanks, Just a couple of quick questions in terms of PSP exposure in Q3 and Q4, it was 7% this quarter . should we be thinking of double-digit exposure to PSP or at least a growth in percentage of PSP from a platform perspective.

And then just to follow-up on the retail question.

Clearly there has been some weakness in retail, not just in the sector but in other sectors as well.

With you just talk a little bit about specifically the kinds of titles that you are seeing retailers be a little more cautious about this holiday season?

Thanks.

I would say on the PSP, I think it is a little bit early and just trying to do a little bit of math relative to percentage of mix.

I would put it sort of in the same category given the strength of -- if you think of all things that are going on in the third quarter from the 360 launch to just the strength of our overall title line-up.

I think it is probably going to -- sort of hold there, and I don't know, 7% to 10% or so category.

I think the way we look at it which is -- is that this is a brand-new segment for us.

Fundamentally.

We never had an overly strong position in the hand-held market.

It really hasn't met sort of our -- it just hasn't been where we have played.

As Larry said we are sitting here in North America at 27% total share and number one on this platform.

So that has put us in a whole new world as far as handheld.

I think as far as our numbers go, we are -- 11% or so year to date.

Just looking at the NPD data for the hand-held.

With regards to your second question, it looks like what's happening is that known brand names and sequels are doing well in that mix.

In addition, titles that don't -- don't have the demand indicators that are saying that it is in the top 20 aring also getting hurt a little bit.

So games that feel like they are outside the top 20 aren't doing so well with retailers and new ideas that don't have proven track records and brandings seem to be at risk.

Thanks everyone for joining us today.

That concludes our call.

Thank you.